Best Practices in Cultural Due Diligence

Axial

Mar. 26, 2013, 9:58 AM

This article on cultural due diligence is the second installment of Axial's six-part series on the Best Practices in Due Diligence. The first installment discussed the importance of tax due diligence. Future articles will discuss legal, operational, and other due diligences.

Despite being intangible and undefinable, culture can be one of the primary determinants of a deal's success. While vetting cultural pain points and planning for possible differences can lead to a smooth integration, neglecting cultural issues can lead to massive turnovers, employee dissatisfaction, and a subtractive deal.

For Total Safety, a leading integrated industrial safety services provider and Axial Member, cultural due diligence is one of the basic prerequisites for any deal. "If we cannot provide good evidence of cultural alignment, the rest of the business doesn't matter: you would risk buying some assets but losing the people to run the business for you," explained Stenning Schueppert, Total Safety's SVP of Strategy, Marketing & Corporate Development.

However, conducting proper cultural due diligence is particularly difficult. "One of the biggest challenges in cultural diligence is the issue of confidentiality," explained Schueppert. "While culture permeates the entire organization, you cannot simply go to the shop floor prior to closing and ask all employees frankly what they think of the company and what they think of Total Safety." The inability to question employees makes defining the amorphous element of culture even more difficult.

To overcome this uncertainty, Schueppert offered some strategies to help identify the culture of an organization and to determine their alignment with your business identity.

Understand the Turnover Rates

According to Schueppert, turnover rates and trends can be one of the best ways to measure the strength of a company culture. He explained, "It is necessary to ask the company about its turnover rate, where its employees move to, the last key employee to leave, etc. If there is a noticeable turnover trend - all employees leaving for the same company or 50% of management team leaving to start a competitor, as examples - that should offer unique insight into culture and the businesses."

To gain deeper insight into reasons behind departures, ask to review relevant exit interviews (if conducted). If common themes emerge - like unsatisfactory pay, unsatisfactory conditions, or bad managers - make sure they are not critical to your post-acquisition plan.

While major departures may signal a red flag, no turnover can be just as alarming. "If a significant number of employees have held the same position for too long, they may fear change and be resistant to acquisition," explained Schueppert.

Review Internal Documents

While turnover rates can identify the strength of a culture, the internal documents can shed light on some of the core values and principles of the organization . "You should ask to see any employee newsletter, intranet, or social enterprise network," says Schueppert. "These channels and materials are probably the closest you'll get to actually speaking with employees about culture. You can see how employees interact with one another, how they participate in company activities, etc."

Internal documents also offer insight into the thinking of senior management. While you can question them about culture, internal documents can provide evidence of previous actions and discussions. Schueppert explained, "You should ask senior leadership for the budget and minutes from old staff meetings, management retreats, or board meetings. These also offer great insight how they think about the company and about the culture."

Validate the Culture with External Sources

To supplant your understanding of the company's culture and identity, it is equally important to corroborate with external sources. Unfortunately, licentious business practices have a tendency to escape any formal documentation, and are only revealed when consulting with a third party.

Schueppert explained, "Before moving too far along in a deal, I ask my guys in the field if they know about the business and for their impressions. If several independent sources offer you the same impression - either positive or negative - chances are it is accurate." This external validation recently saved Total Safety from engaging in serious conversations with a seemingly attractive company. As it turns out, the target's core customers were significantly different, and misaligned, with Total Safety's culture.

If you do not have any immediate sources, there are a variety of other channels to corroborate the culture. "Your customers are a great resource of information in your field contacts do not have any information," explained Schueppert. "While they might not have as detailed knowledge, they can offer a worthwhile gauge." If you feel uncomfortable polling your customers then ex-employees, market advisors, or industry peers also make as great sources of information.

In the case of a new market, or no consultable confidants, patience is vital. "You should date before you marry," commented Schueppert. "We recently did a deal in Europe, which was a new market for us. We were able to get comfortable moving forward with the deal because we had known the CEO for five years and we had engaged in numerous discussions around partnership." While Total Safety had little external substantiation for the culture of the European company, Schueppert confirmed, "From the length and strength of our relationship, multiple site visits, and the nature of the conversations, we knew our cultures would match."

Learn from the Owner Operator

Ultimately, the best person from which to learn company culture is the existing owner operator. "No one will know the company culture better than the current owner-operator," says Schueppert. After all, most small companies have a top-down culture defined by the founder and senior management.

It is possible you may learn more about culture from the current CEO by asking why he is selling rather than directly about the culture. According to Schueppert, "Truly understanding why the owner-operator is selling may give you a good indication of business: If he cannot give a good reason for selling, he is probably fed up of managing a difficult business and simply wants to monetize his investment. It may be difficult because of market factors, but it also may be difficult because of a dysfunctional organization."

These information sources and mediums can offer the greatest insight into the qualities of a company's culture. Once the culture is understood, the feasibility of the deal can be assessed and appropriate cultural integration practices can be implemented.